Price improvement has been used in the financial markets for many years and refers to the filling of an order at a price between than that bid or offered. Price improvement is used extensively in the equities trading market.
From the point of view of the taker, sometimes referred to as the active trader or aggressor, price improvement occurs when the taker receives a better than requested price. In an equities market this may he due to the order being fulfilled through a source that is prepared to trade at better-than-market price, for example to improve their order flow.
A version of taker price improvement is implemented as an anonymous trading system operated by EBS Dealing Resources, Inc of New York USA to trade foreign exchange spot and precious metals. The EBS system, which is used very widely in the Interbank market, considers taker orders to be limit orders. This means that they are considered to be buy-up-to or sell-down-to orders rather than buy-at or sell-at orders. When the system finds a match, and there is a difference between buying and selling price, the difference is given to the taker. Done deals are displayed to the taker in a deals panel on their workstation and a price improved deal is indicated by an icon (a smiley ) next to the deal as shown below:
AmountTimeBuy/Sell(Million)RateDeal CodeCCY21.13Buy11.8331 XPBXGBP/USD
Price improved deals occur frequently when the market is busy and volatile.
From the point of view of the maker, or passive trader, price improvement occurs where the maker improves the price of a quote, that is a bid is increased or an offer price decreased, slightly to increase the chances of getting dealt. An example of maker price improvement is a system operated by eSpeed Inc of New York USA and described in GB-A-2,389,687. The eSpeed system allows the maker to improve his price by a range of pip fractions, called PI increments. Other traders can tell a price improved order by a PI icon (a diamond) displayed next to the order. A party who includes price improvement in their order is referred to as the PI contributor while a party acting on a PI price is referred to as the PI recipient. Both parties benefit as the PI contributor is increasing their chances of being dealt and the PI recipient is getting a better price by acting on the PI order.
The eSpeed system includes a PI best feature which allows the maker to use PI only when necessary to improve their probability of execution. This enables a maker to maximise the likelihood of securing a trade with the minimum number of PI increments possible.
The eSpeed system as disclosed in GB 2,389,687 defines price improvement as a price that is improved over a touch price. In the eSpeed system, a market moves from a bid/offer state to a trade state when a trader hits or lifts a bid/offer posted by another trader. That hit/lift price becomes the touch price of the market for the selected item and the market becomes active for that item. A price improved bid/offer has a price that is improved with respect to that touch price. The touch price is a price that is seen by all traders in the market.
Once a price improved order has been dealt, the eSpeed system distributes at least a portion of the difference between the touch price and the price-improved order price between the parties to the trade and the system host.
A further example of price improvement in electronic trading systems is disclosed in WO2004/045214 of Boston Options Exchange. This application discloses conducting rapid automated auctions in which participants can provide price improved orders. As with the eSpeed system, the price improvement increment is smaller than the minimum price variation of the instrument being traded. Price improved orders may be submitted during a limited time period and are defined as an improvement over the best bid or offer prevailing across multiple markets for the particular instrument. This is similar to the concept of touch price, an established market price for an instrument that is visible to and dealable by all traders in the market place.
Although the idea of implement price improvement is attractive to the foreign exchange markets, the technical solutions proposed in WO04/042514 and GB-A-2,389,687 are unworkable in the Interbank foreign exchange (FX) markets as the concept of a touch price does not exist.
Unlike the equities markets, the dealable price that is available to an F/X trader varies depending on the credit relationship the taker's trading floor has with other trading floors of currently active market makers. A quote submitted by a maker that has no bilateral credit with the taker will be filtered out by the system and not shown to the taker. It will, however, be shown to any other taker that has bilateral credit with the maker's trading floor. Thus, the market view seen by a trading floor is specific to that trading floor and dependent on that trading floor's credit relationships. The manner in which prices are credit-filtered prior to distribution to trading floors is described in U.S. Pat. No. 5,375,055 (Togher et al.).
From a maker's perspective, a quote submitted on the EBS system might be the best quote, and first in line to be dealt, on almost all trading floors in the system, even though it is worse than both his dealable price an the best price on the system, which could be entered by a party to whom few trading floors extend credit.
Thus, a marker at a large bank may see a dealable price of 33-34 (bid-offer) on his EBS display but could submit a bid of 32 and be dealt immediately, even though his dealable price remains unchanged. In this case the 33 dealable bid price was submitted by a smaller bank that has credit with a limited number of floors. Many traders in the system saw a dealable price of only 31-34 and a best price (which is not credit screened) of 33-34. This makes the makers bid of 32 attractive and it was taken immediately. This situation is common in credit screened markets and illustrates that there is no concept of a market touch price and so no possibility of price improvement with respect to touch price.
A maker is always uncertain of the position in the queue of his quote as he is necessarily unaware of the whole market in a credit screened system. There are ways in which the maker can gain information. The first is by looking at the done deals on the makers display. This shows all deals that have been executed on the system regardless of credit relationships and by observing where other trades are taking, the maker may gain an indication of the proper quoting level. The deals panel shows lowest bid that was taken by a single sell order, the lowest sell that was dealt in a single time slice etc. Thus, in the above situation, the trader would see from his deals panel that a number of trades had been “given” at 31. From this the trader could deduce that a dealable bid of 33 was not being seen, and so not available to some or all of the market.
The second technique is described in U.S. Pat. No. 6,282,521 and is implemented on the EBS trading system and is referred to in the market as “red quote”. The system notifies the maker when the maker's quote is close to the head of the queue at a significant percentage of the trading floors by turning the quote display red. In the example above, the 32 bid would turn red even though it is worse than the dealable price displayed on the maker's workstation.
Thus, although it is desirable to implement price improvement on a credit screened trading system, there is no available mechanism for doing so due to the absence of a touch price and the distribution of different dealable prices to different trading floors. Furthermore, for price improvement to be attractive to users the system must only apply it when it is necessary.